June 2, 2008 - Pimco’s Co-CEO and co-CIO, Mohamed el-Erian discusses his new book, When Markets Collide, with Barron’s, which puts today’s market accidents in a unique perspective. Both the Barron’s interview and his book are must reads. Here is an excerpt:
What are the biggest things people missed?
Under a "just-in-time" risk-management mindset, people waited for the turn before taking risk off the table. Hubris took over. People believed these new derivative products would allow you to reposition your portfolio after the turn as opposed to preemptively. But that wasn't a possibility with credit products and subprime, and losses were huge. People misinterpreted what these instruments can do, and didn't retool significantly.
Who's the poster boy for this way of thinking?
The book quotes Chuck Prince, [the former CEO] at Citibank, on the front page of the Financial Times, words to the effect that when the music stops it will be messy, but as long as it's playing he's on the dance floor dancing. Within weeks the music stopped and people couldn't get off the dance floor. In many of these sophisticated firms, the traders did things that neither the middle nor the back office could support, and the result was very big losses. It's like pipes in your house that are very old. Every once in a while, one will rupture below and you have a very messy cleanup.
When Markets Collide: Investment Strategies for the Age of Global Economic Change, Mohamed el-Erian, co-CEO, Pimco